Thursday, January 05, 2012

Currency Wars

I just finished the new book "Currency Wars - The Making of the Next Global Crisis" by James Rickards. It was very interesting. He describes several past currency wars and lays out his argument that we are currently in one. Rickards describes the causes, symptoms, and effects of these wars, and ends with a list of possible outcomes for the current one. He's gotten a lot of attention from this book, and it's easy to find audio and video interviews of him online.

The most popular measure of growth is increases of GDP. Gross Domestic Product (GDP) = C + I + G + (X - M). Distressed economies have stagnant or declining consumption (C). Investment (I) is tied closely to consumption. Government spending (G) can be boosted independently, per Keynesian economic theory, however governments need more taxes or borrowing to fund that spending. Voters don't like either of those options. "In an economy where individuals and businesses will not expand and where government spending is constrained, the only remaining way to grow the economy is to increase net exports (X - M) and the fastest, easiest way to do that is to cheapen one's currency."

This is exactly what the Fed and US Treasury Secretary are currently doing. Unfortunately, so are the economic leaders of other countries, for exactly the same reasons. This is a currency war.

Rickards predicts these possible outcomes of the current currency war:

1) Multiple Reserve Currencies The dollar would no longer be the single reserve currency around the world. Nations would keep reserves in dollars, euros and yuan to mitigate sensitivies to volatility in any one currency.

2) Special Drawing Rights (SDR) SDRs are a form of "money" created by the IMF that already exists, but is shrouded in mystery. It is backed by a basket of other currencies. SDRs might become the dominant currency for all international trade, leaving extant currencies for domestic transactions in each country.

3) Return to a Gold Standard Resumption of a gold standard at any TBD fractional backing, would result in the price of gold rising to about $7,500 per ounce. Gold asset sales would be taxed at up to 90% in a windfall profits tax scheme.

4) Chaos A chaotic, catastrophic collapse of investor confidence triggering emergency measures by many countries, including use in the US of the International Emergency Economic Powers Act of 1977 (IEEPA). In the end, a very long period of economic gloom would result.

Rickards thinks the last option is the most likely.

In his conclusion, he says:

"As applied to capital and currency markets, the correct approach is to break up big banks and limit their activities to deposit taking, consumer and commercial loans, trade finance, payments, letters of credit and a few other useful services. Proprietary trading, underwriting and dealing should be banned from banking and confined to brokers and hedge funds." ... "Derivatives should be banned except for standardized exchange-traded futures with daily margin and well-capitalized clearinghouses."

I don't think that will happen. And that's unfortunate. I liked the book and I recommend it to anybody interested in the topic.